Four Opportunities from Higher Interest Rates and Inflation
There are always two sides to every coin. Higher inflation constricts the economy, but what gets missed is that it also resets the economy for the future. The last few years of zero-bound interest rates made money too cheap, and things got frothy. Now that we are in the reset phase, it is a good time to consider how the Federal Reserve’s policy of higher interest rates (to break the back of higher inflation) can also benefit us.
Savers Versus Borrowers
2022 will be known as the year when savers started to be rewarded. I’m not talking about the stock market. Over the years, with a zero-interest-rate policy by the Fed, people who borrowed were enjoying the ride. Low interest rates allowed them to borrow more, whether for homes, cars, education, or just a big toy (like a boat).
Savers, on the other hand, were not happy since they could not get a return on cash. And putting money into anything with a slightly longer holding period (CDs, Treasuries) just locked their money up longer at low rates.
That script has flipped. With rising interest rates, everyone can get a return on their cash reserves if they look for it (read: look online versus the large traditional banks). And if you want to lock money up for a little longer, CD or Treasury rates can give you a decent return. While these returns might still be below inflation, at least you can get something for money that most people are holding for emergencies, larger near-term purchases, or tax payments.
Broader Tax Bracket Bands
Each year, the IRS adjusts brackets for inflation, and since inflation is much higher this year, the bands are expanding more. For example, in 2022, a married couple (filing jointly) would be in the 12% tax bracket on income up to $83,550. In 2023, that income number is now $89,450. That $5,900 change is approximately 7%.
The importance of this lies in the strategy you might use for different issues. For example, that is an extra $5,900 of a Roth conversion at 12%, or $5,900 more capital gains at 0% (capital gains are taxed at 0% if you fall in the 12% income tax bracket). This may or may not matter, as it will need to be reviewed on a case-by-case basis. But I point it out because sometimes there are opportunities at the edges.
Increased Retirement Plan Contribution Limits
For those still saving toward retirement, contribution limits to a 401(k) were also indexed upward more than most years due to higher inflation expectations. Thus, for 2023, you can put $22,500 into a 401(k) (versus $20,500 in 2022), and you can add a catch-up contribution of $7,500 (versus $6,500 in 2022) if you are over age 50.
Traditional and Roth IRAs had a similar jump. In 2023, you can save $6,500 per year into these plans instead of the $6,000 allowed in 2022. However, the catch-up contribution limit for those over age 50 stayed at $1,000.
Higher Social Security COLA Increases
Higher inflation has forced Social Security benefits higher as well. For 2023, benefits will increase by 8.7%.
Suppose someone was considering starting benefits at age 68 but decided to hold off one more year and do it at 69. That one-year wait would give them an extra 8% boost to benefits* on top of the 8.7% cost-of-living adjustment (COLA), totaling a 16.7% higher benefit in just one year. Delayed gratification can be a benefit this year.
Bonus tip: Review your asset allocation for 2023 and beyond. The strategies that got us here might not be the strategies that lead in the next few years. And I don’t say that to cause concern; there could be real opportunity in an economy that is returning to a more normal interest rate policy.
Higher interest rates remind us that planning is a verb, and a plan is a noun. Many people might think they have a financial plan, something they do once and forget about it. But planning is a continuous, active effort to optimize your situation. 2023 is a year where that is even more evident if you know where to look.
*The opinion of the author is subject to change without notice and must be considered in conjunction with relevant regulation, as well as subsequent changes in the marketplace. Any information from outside resources has been deemed to be reliable but has not necessarily been verified. Each individual has unique circumstances to which this information may or may not be relevant. Under no circumstances will this information constitute an offer to buy or sell and it does not indicate strategy suitability for any particular investor.
*For every year you delay benefits between full retirement age (FRA—usually age 66, but moving towards 67) and age 70, your benefit will increase by 8%. This increase is done monthly, so at any time, you could start claiming and get the increase pro rata.